Concerned about gullible investors being defrauded by certain companies existing only on paper, capital markets watchdog Sebi is planning to conduct surprise inspections of such entities to bring them to book.

The Securities and Exchange Board of India (Sebi) is working on a comprehensive framework to deal with the listing and trading of only-on-paper companies and tackle this menace, a senior official said.
"The framework would also include an objective selection criterion for selecting companies for inspection, while an indicative questionnaire for surprise inspection of such companies would also be put in place," he added.

The typical modus-operandi of such entities involves setting up of a company, followed by tall claims about their proposed business ventures. Then an exercise is undertaken to collect funds from investors, including through IPOs (Initial Public Offers) of shares and issuance of other securities.

However, their business plans remain on paper only and they later divert funds collected from investors for personal gains or for other purposes, while leaving investors in lurch.

In one such case, which currently under investigation, one company raised money through IPO for setting up a manufacturing plant in West Bengal a few years ago and later even also announced expansion of this facility. However, it was found during an on-site inspection that the plant does not exist at the given address.

There are cases where such companies have remained listed on stock exchanges by making wrong periodic disclosures to meet the regulatory requirements, but it has been found that they did not actually indulge into the businesses listed by them.

There have also been attempts to raise funds for second or third time by some entities, presumably to finance their tall claims about business expansion, but the money is again diverted for other purposes.

In some instances where Sebi and other regulatory or administrative authorities have issued notices to such entities, make-shift arrangements have been made by them to show at the time of inspection that they were carrying out their claimed businesses.

Typically, the size of funds raised by such companies are smaller in nature to avoid any immediate regulatory glare, while similar sets of entities have also been involved to follow the same modus-operandi to collect money multiple times by setting up new companies.

The issue came under the scanner after a probe into diversion of funds raised by various companies through IPOs and an analysis of trading pattern for shares of such firms.